IN BRIEF:

Dangers of new money

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By PSM Rao Jan 28, 2014,

Jan 27 2014, 23:41pm ist

updated: Jan 27 2014, 23:41pm ist

Information revolution has undoubtedly brought many new and fascinating things to make life easier. But the bitcoins, a new type of money, facilitated by the same information technology does not seem to be very useful; rather it is a harmful invention to categorically say without mincing words.

Bitcoins and its several clones like litecoins, bbqcoins and dogecoins are growing in number phenomenally, much before people understand what they are and how they are used. Launched in 2009, there are already 12.26 million bitcoins in circulation against 21 million target. With the value of each coin being equal to US $ 870 by mid-January, 2014, their total stock is equal to $10.66 billion. This is not a small amount; as per the UNO data for 2012, there are as many as eighteen countries with the Gross Domestic Product less than this amount. The GDP of bottom seven countries adds up to $10.73 billion, roughly equal to the current value of bitcoin stock.Central banks of different countries have got alarmed, and rightly so, with the bitcoins’s business. The People's Bank of China prohibited Chinese financial institutions from using bitcoins from December 5, 2013. The RBI on its part has cautioned the users, holders and traders of bitcoins and the like, about the potential financial, operational, legal, customer protection and security related risks that they are exposing themselves to.

What are bitcoins anyway? A layperson gets more confused with the explanations available on the internet which run something like this, “Bitcoin is known as virtual or digital or crypto currency; it is the first decentralised P2P (peer-to-peer) payment network that is powered by its users with no central authority or middlemen.”So, some very simple explanation on what the bitcoins are and how they work is necessary to know good or bad about them. Simply put, bitcoins are computer generated currency. They do not exist in physical form like coins and currency notes. They are created in computers and live in them. In the virtual (computer) world like our emails are stored in our email box. The bitcoins are designed in such a way that no one can pilfer them. Highly sophisticated computers which are naturally very costly are used and very complex mathematical process is involved to create the code numbers through which they can be accessed by the true owners.How do they work? Two different keys, say codes, are generated; one is public key which enables all the bitcoin users to see all the transaction and a private key only the owner can use to open his electronic wallet. In fact the persons who want to use bitcoins are required to create their wallets in their computers or other electronic devices. Once that is done they can buy bit coins; there are several bitcoin exchanges now. Or they can acquire bitcoins, in return of some sale, the bitcoins which the seller deposits in the buyers wallet.

Block chain

All the wallets in the world are recorded at one place or electronic general ledger known as ‘block chain’. This doesn’t mean that everybody’s identity is known to every other. They are known only as distinct wallets and their public keys. So, the transactions are anonymous. The creator of the bitcoins, too, is anonymous till today. A person (no one knows whether it was a man or woman or a group of persons) with fictitious name Satoshi Nakamoto created bitcoins. Of course, this creator has disappeared from the seen now, although bitcoins usage is fast expanding. People can buy and sell goods and services online, from anywhere to anywhere on globe, using their bitcoins. They need not use their credit or debit cards or regular bank accounts; they can pay and receive payment in return of their sales, in bitcoins. Transactions are carried through their bitcoin wallets using their keys – public and private. No one is bothered what they buy and who they are.

The potential risks are that bitcoins are being used as money. But they can’t be a substitute for money and there are many evils associated with them as observed by the economists like Paul Krugman. The money, to be accepted as money, should perform four major functions as per William Stanley Jevons, a 19th century British economist. It should be a medium of exchange, a common measure of value, a standard of value and a store of value. The modern economists condensed them into three functions: medium of exchange, unit of account, and store of value. The critics argue that the bitcoins may be functioning as medium of exchange and unit of account, but they cannot have the store value. Its value is seen to be very volatile. The value is going up and down all the while.

For instance one bitcoin was worth $ 1203 in December 2013; it came down to $ 870 in 15 days. It was equal to just $19 in February 2013. The other problem is the bitcoins are not created by any government or central authority. So there is no guarantee for their loss. Similarly, they are very convenient medium for the illegal activities since the identity of persons dealing in them is anonymous. Several instances of illegalities have already come to the fore.

So, RBI needs to take further urgent steps in addition to its mere advisory. That its simple caution did not work is evident from the media reports that the bitcoin operators’ business is going on as usual after a short break following the RBI’s warning.

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